By Maureen Aylward
We asked our Zintro experts about their scenarios regarding the current US debt ceiling issue. If the US does not reach an agreement to raise the debt ceiling, what might happen? We have several perspectives.
Kevin Lenox, an expert in investment management, says that serious action must be taken to reduce government spending, but cooler heads in Washington need to appreciate the unfavorable asymmetric risks of their actions. “There’s a strong likelihood that a US default would immediately provide the trigger for a lower US credit rating. In turn, this could lead to rising interest rates, a falling dollar, and global recession,” says Lenox.
Lenox says that a lower credit rating would cause investors to demand a higher interest rate to compensate for the perceived increase in risk. This would raise borrowing costs for the US consumer and worsen the deficit by increasing required interest payments. “As we’ve seen with countries like Greece, interest rates can move significantly higher if investors lose confidence in the ability of the government to manage its fiscal policy,” he says. “The US dollar would face selling pressures due to the tarnished status of the dollar as the primary reserve currency. As a result, US equities and bonds could face significant headwinds if foreign investors and central banks reduce their dollar denominated assets.”
Lenox explains that a falling dollar provides a lift for commodity prices that might continue to fuel widespread inflationary pressures in many emerging market countries.
“The repercussions from a US default could cause a painful and disorderly decline in global asset prices that could serves as the tipping point toward another global recession. Congress should take a step back and remember the lessons learned from the integrated nature of markets from the Lehman collapse and the fallout after the initial TARP vote.”
Madhaven Iyengar, an international tax consultant, says that if the US defaults on its debt, investors who own US stocks and bonds will take a big hit. “This will affect the big banks, corporations, and even other countries, pushing some toward bankruptcy,” says Iyengar. “The global banking system has such huge exposure in US assets and the dollar that it will continue to have impact until the US raises the debt limit.” For example, when businesses and corporations lose money and cannot borrow to stay afloat, expansion plans get shelved and that can slow down economic progress.
“The US dollar is considered the safest currency in the world, and when it drops, it will create chaos in financial markets. China and Europe will be wary of lending more money to the US. When they do, it will be at higher interest rates and that will affect the global marketplace.” Iyengar says that the dollar is likely to remain under pressure. “As the debt situation continues, countries across the world will lose faith in US Treasuries and will look to diversify to other currencies,” he says.
Jean-Pierre Khordoc, an executive in global development and international finances, says that despite its slow progress due to the rivalry between the two prevailing parties, the US has no choice but to reach an agreement to raise its debt ceiling. “The US cannot afford to take any other action. Anything else would simply bring the world to a major financial collapse and economic meltdown, he says. “In the US, we would be in total disarray with unimaginable financial and economic implications.”
What do you think?
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Hi Maureen,
the subject of the Greece crisis is very broad. what exactly are you looking for? I have worked at the IMF for 23 years and executive assistant to the dean of the executive board. I can help there, please provide further information.
regards
Aida
I understand the consequences of not raising the debt ceiling, but when does continuing to raise the debt limit become a problem? Won’t we just keep piling up debt? Government spending really needs to be cut.
I totally agree amber. But to repeat my comment from above:
“Looking at this debate in the news, I’m amazed at the lack of ability to separate the long-term problem (too much debt) from the short-term problem (funding day to day operations). Comparing the US gov’t to family finances is a canard. How many families do you know who can issue bonds and print currencies? Of course debt is a problem, but rattling the bond markets in the short term makes things worse, not better. Where are the adults in the news media?”
So, of course gov’t spending needs to be cut, but RESPONSIBLY and GRADUALLY. The way the Republicans are going about it is dangerous to the country’s economy and global stability. But deficit planning takes adults, and apparently all we have in congress are children. The news media is no better. Why can’t we have a real long-term discussion about deficit spending, and get away from all of these crises and fear-mongering? Damn, it p*****s me off!
There WON’T be a default.
The President can order the ceiling to be raised by constitutional law. This would be a last resort.
Would someone please forward the experts’ comments to Congress? It seems they need reminding.
Would those holding US paper, for a short time, not raise interest rates so as to avert the meltdown scenario? Is the US economy too big to fail?
Looking at this debate in the news, I’m amazed at the lack of ability to separate the long-term problem (too much debt) from the short-term problem (funding day to day operations). Comparing the US gov’t to family finances is a canard. How many families do you know who can issue bonds and print currencies? Of course debt is a problem, but rattling the bond markets in the short term makes things worse, not better. Where are the adults in the news media?
What I think many do not realize is that Congress has already approved the spending through the budget process but now are looking at the end result of their decision and are pulling back to look like they are now doing their fiduciary responsibility. It is posturing in its worst form. I agree, we have sent 535 – 5 year olds to Washington to be our representatives. YIKES!! The debate between the budget and the debt ceiling are mutually exclusive but one party is leveraging one to get concessions on the other. This deal should have been done last week but because the President asked for a small increase in taxes, the other side walked out. Not realizing that $120B really means an average of $33 per taxpaper per year. To keep our country solvent and not have our individual wealth eroded because of the emotional volitility of the stock market, send me the bill. I will gladly pay the $33 to avert a significant decrease in value in my savings and retirement funds. Without realizing it, Congress is levying a tax on you with the decrease in your personal wealth. I recently read a really good blog post on this topic. (garyshimun.com)